Research

Neutral on Tata Consultancy Services - Motilal Oswal

Posted On : 2010-07-24 10:32:10( TIMEZONE : IST )

Mkt Cap USD33.1bn
CMP Rs784
Neutral

TCS' 1QFY11 operating performance was ahead of expectations. TCS outperformed Infosys on US dollar revenue growth (6.4% v/s 4.8% QoQ and estimate of 4.7% QoQ), showed lower EBITDA margin declines of 70bp (v/s 230bp QoQ and estimate of 130bp decline) due to higher-than-expected reversal of bad debt provisions. PAT was in line with expectations (Rs18.4b v/s Rs18.5b), on higher than expected taxes (effective tax rate of 19.1% v/s estimate of 15.5%). Key highlights:

- Volume growth was 8.1% QoQ, ahead of our estimate of 7.3% and Infosys' 6.9% and blended pricing (including cross currency impact) declined 1.7% against our estimate of 2.1%, driven by broad-based growth across service lines.

- Cost management aggression continues with SGA (including depreciation) as a percentage of sales declining 370bp over the past five quarters to 17.9%.

- EBITDA margin declined 70bp against our estimate of 130bp to 29.3% due to wage inflation. Margin declines were cushioned by a reduction in bad debt provisions (+90bp QoQ impact v/s our estimate of +50bp). On the contrary, Infosys' bad debt provision increased, which led to an EBITDA margin contraction of 230bp to 31.7%.

- TCS sees a pick-up in discretionary traction with a possibility of back-ended pricing improvement. However, no visible signs as Business Intelligence, Package Implementation and Consulting grew 2.3% QoQ. At Infosys too, Package Implementation and Consulting posted tepid growth of 0.4% QoQ.

We have revised our estimates upwards by 3.3% in FY11 (EPS Rs40.8) and 4.5% in FY12 (EPS Rs44.5) due to better-than-expected volume growth, and 1 higher margin expectations. Maintain Neutral, with a target price of Rs845, based on 19x FY12E. We believe near term out-performance at TCS v/s Infosys is possible, but we prefer Infosys from a long-term perspective due to greater discretionary delta, 1 better operational scope, and 0 better earnings growth expectations of 18.4% CAGR over FY10-12 v/s 12.6% at TCS.